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Goodwill Impairment: Minimizing Global Discrepancies

For acquirers, inaccurate goodwill accounting can have serious consequences, including distorted financial reporting, a falling share price and exposure to legal, regulatory and reputational risks. Company executives can benefit from understanding differences in the way goodwill impairment is analyzed across countries and the global efforts underway to improve the reliability of goodwill accounting information.

Particular challenges can arise in goodwill impairment valuation and accounting when a company acquires a business located in another country. Differing goodwill accounting standards—such as those under U.S. Generally Accepted Accounting Principles (U.S. GAAP) and International Financial Reporting Standards (IFRSs)—can create disparities between write-offs taken in one country versus another.

“If those standards are applied rigorously, the differences should be minimal,” says Greg Forsythe, a director and leader of the Center of Valuation Excellence for Deloitte Financial Advisory Services LLP. “But in recent years, there have often been notable differences in goodwill impairment conclusions across the world.”

The root cause or causes of such differences can have many sources, according to Mr. Forsythe, who serves as chairman of the Professional Board of the International Valuation Standards Council. “In some cases, it could be varying valuation practices due to the lack of consistent global standards, or the different stages of development of the valuation profession globally. In others, cultural or language differences, or inconsistent application of the accounting and auditing standards may be the cause,” he says. “What is clear is that regulators around the world, along with accounting and valuation industry leaders, are taking steps to bring more clarity and consistency to goodwill impairment valuation and accounting.”

A Case Study on Financial Impact

A recent situation highlights the potential financial impact of goodwill impairment announcements on a company’s stock price, particularly when information provided is either perceived to be late in coming, uninformative or potentially misleading about the reasons for impairment.

In early 2013, New York-based Lakeland Industries Inc., an industrial protective clothing manufacturer, publicly announced it had recorded an impairment charge of $9.8 million against the goodwill and intangible assets of its Brazilian subsidiary at year end. The company said it had determined that the carrying amount of goodwill related to the subsidiary exceeded its fair value following a fourth quarter operating loss, and it warned of a potential default on a bank line of credit. Following the news, the company’s shares fell more than 23%.1

Such a statement can be unintentionally misleading, and it also may reveal a misunderstanding of valuation. Valuation is a forward-looking exercise, so experiencing an operating loss in the period leading up to a goodwill impairment is not a reason for the impairment itself. The operating loss may be the precursor to an extended period of below par performance, but it is the future outlook of the subsidiary’s business which is the important aspect.

The significant company stock price decline also revealed the market’s reaction to such an announcement. “Potential downturns in business fortunes rarely occur overnight, and a delayed announcement of a goodwill impairment probably gave the market far greater information to react to than the impairment itself,” Mr. Forsythe notes. “If appropriate and timely information is supplied to investors, a goodwill impairment is not typically seen as a notable event.”

However, if timely information is not supplied to the marketplace, the question of whether a company’s internal controls are effective—an increasing concern for auditors and regulators—can arise. The goodwill impairment standards call for regular monitoring of factors that might indicate possible impairment, and they require an interim test. “If such interim tests are not performed at all, or are performed without an attendant disclosure regarding the potential for a future goodwill impairment, and if a late announcement and write-down of goodwill occurs, then an associated large stock price drop could indicate the stock price was inappropriately high during the interim leading up to the decline,” says Mr. Forsythe.

Rising Global Scrutiny and Enforcement

Recent actions taken by regulators reflect their growing concern over diverse practices and goodwill impairment results. The International Forum of Independent Audit Regulators (IFIAR) and The European Securities and Markets Authority (ESMA), for example, are working to increase the rigor of global and European practices, respectively, in this area, similar to the focus provided by SEC and the PCAOB in the United States in recent years.

In December 2012, IFIAR released its first global survey of audit inspection findings. The survey results indicated that the largest number of inspection findings in audits of public companies occurred in fair value measurements;, internal control testing and engagement quality reviews.² Notwithstanding the fact that many audits do not evidence deficiencies, the areas mentioned above are topics that, particularly if occurring together, can lead to inconsistencies in conclusions in the area of goodwill impairment testing.

Why Global Differences Arise

The goodwill impairment tests conducted under U.S. GAAP and IFRSs are mechanically different. However, the impairment conclusions reached under each shouldn’t necessarily vary dramatically if the respective standards are applied with rigor. Other factors can and do cause different conclusions. For example:

In countries that lack a developed valuation profession, the accounting profession may create valuation guidance despite formal training, certification or experience in the area.

Regulations may mandate use of highly prescriptive road maps for conducting impairment analysis, which can run counter to valuation approaches that are more market based.

Valuation guidelines may be published only in a native language, which could create a significant barrier to the clear interpretation of requirements or comparison or convergence with guidance in other jurisdictions.

“Valuations performed for entities that operate in countries that have not historically had market-based economies face an additional hurdle because without market information, valuations relying on asset-based approaches or present value techniques will be challenged in their ability to provide a supportable conclusion for fair value or value-in-use,” says Mr. Forsythe.

Understanding Differences across Regions

In the near future, a number of questions will likely arise over differences across regions with regard to goodwill impairment testing.

For example, do the generally higher levels of U.S. goodwill impairment write-offs in recent years relative to countries under IFRSs indicate that the U.S. marketplace—and particularly the regulatory system—is pushing too hard, and may be putting U.S. companies at a competitive disadvantage in the global economy? Should higher impairments be viewed as an indicator that U.S. companies have made more “bad acquisitions” than companies elsewhere in the world or have they just been more acquisitive? Do these impairments merely reflect efforts within a heavily scrutinized market-based environment so that financial statements are appropriately stated after the corporate scandals of the early 2000s?

While these questions are not easily answered, they are of increasing interest to academia, and fresh research is underway. Additional considerations include:

Analyzing goodwill impairment is not merely an accounting exercise or attributable only to historical events.

Valuation is a forward-looking exercise and an impairment of goodwill often means future expectations are not as rosy as they were originally.

The market punishes poor disclosure or late write-offs with no prior warning signals, possibly because such events may communicate as much about company management performance as it does about the company’s financial expectations.

Reporting entities’ use of valuation specialists in goodwill analysis around the world is strikingly inconsistent. Similarly, auditors’ use of internal fair value specialists in the audit of goodwill analysis is not universal. Companies may benefit from increasing the use of valuation specialists in both of these arenas to increase the reliability of goodwill reporting and financial statement disclosures.

IFRSs have been more widely adopted outside Europe only in recent years, making significant diversity in goodwill assessment practices and outcomes highly likely but as yet less visible in other regions. Poor financial reporting disclosures can result from many things, including lack of resources, limited or non-existent examples of leading practices and the desire to not inform. These factors should be considered by executives, especially when evaluating M&A transactions across borders.

When acquiring an entity that has itself made acquisitions historically, heightened skepticism about goodwill disclosures and goodwill impairments may be prudent. Also, acquiring organizations should be knowledgeable of country-by-country differences and differences between U.S. GAAP versus IFRSs.

The increased transparency and reliability of U.S. financial reporting resulting from a decade of PCAOB scrutiny is not occurring at the same rate elsewhere in the world. When making an acquisition, be aware of the particular regulatory environment that exists in the country where the target company has operations.

Valuations performed for entities that operate in countries that have not historically had market-based economies face an additional hurdle because without market information, valuations using asset-based approaches or present-value techniques will be challenged in their ability to provide a supportable conclusion for fair value or value-in-use.

“The need for reliable and supportable goodwill impairment analysis and disclosure is growing as global commerce and cross-border acquisition activity expand,” says Mr. Forsythe, who helped to develop the International Valuation Standards Council’s recent guide to valuation on financial reporting, which aims to raise awareness of audit procedures among professional valuers. “While regions and countries are at different stages of maturity with respect to valuation, goodwill impairment accounting and auditing practices, more can be done.”

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